Description

Note 1: TEV and EBIT numbers above are on a proportionate basis.

Note 2: I get it. LILA has been written up a bunch. What's different in mine is the bottoms up analysis of CWC by segment, so you can actually go back and compare CWC's historical segments vs. CWC today vs. other telecom companies. When you do, you see that LILA is really only experiencing difficulties affecting ~10-15% of its proportionately owned EBITDA and everything else is performing as you'd expect given standard telecom trends and CWC/Columbus's historical performance. I am happy to explain in comments more detail on how I reached my estimates, but putting all the historical/debt statements together was a pain in the neck, to say the least.

Trader Talk: High quality cyclical-light compounder that is cheap due to complexity. I believe numbers have bottomed out, guidance is conservative, and stock has both strong risk/reward and upside potential from here.

Thesis

LILAK is a difficult to analyze tracking stock which owns several Caribbean and Latam cable and wireless assets, plus a small portion of legacy copper assets. Despite the complexity, LILAK can be boiled down to a simple thesis – LILAK owns a collection of recession resistant businesses which should grow EBITDA by 5-10% organically over the next few years, has strong inorganic growth opportunities, and should earn close to $2 in 2017 adj. FCF/sh, and $2.50 by 2018. The strong organic growth stems from cable/fiber’s structural advantage versus copper, emerging markets lower penetration of video/high speed internet versus developed markets, and the opportunity to increase triple/quad play bundling. Inorganically, LILAK is a “consolidation play” where Malone aims to round up a variety of subscale Latam cable assets, driving returns on equity higher through synergies and prudent leverage.

LILAK is cheap due to its complexity and having missed consensus estimates for two consecutive quarters after the CWC merger. Regarding complexity, LILAK is in essence a holding company for three largely separate business – VTR, Liberty PR, and CWC. Further complicating things, CWC was a holding company in its own right for 8-10 separate units with CWC having different proportionate ownership of each group. And… even further complicating things… CWC had reorganized segments several times in the last three years. However, once one peels through the onion, CWC/LILAK is seeing the same trends seen elsewhere in telecom – cable/fiber growing, enterprise strong, wholesale weak, etc. – with some modest execution issues in specific countries (Trinidad, Barbados, Bahamas) that combined make up less than 15% of LILAK’s proportionate EBITDA. Regarding CWC misses, they have been largely accounting and consensus mismodeling driven, with only slightly miss execution that is more than compensated for in LILAK’s valuation.

LILAK is also an appealing “setup” stock. Following a period as a “broken chart” and technical selling pressure from tax loss and the LBTYA spinoff, the chart has bottomed and I believe sell side consensus numbers have as well. LILAK beat its Q4 guidance in mid-February and guided conservatively for 2017. The recent pullback provides a strong entry point.

Valuation

• Target Case – Assuming Chile/PR grow EBITDA ~6%, the low end of management guidance, and legacy CWC achieves $1B and a $600MM buyback executed below $25 over next two years, LILAK should earn ~$2.50 in 2018 adj. FCF (~$2 in 2017). 15x yields ~$38 per share, which corresponds with ~9x EBITDA, inline with current LBTYA prices and a discount to US peers CABO (11x) and CHTR (10x).

• While LILAK has more risk given emerging markets and execution issues, LILAK has one of the strongest organic and inorganic growth stories in telco, which could easily warrant a premium

• I feel 15x FCF, 9x EBITDA is adequately conservative

• Malone didn’t want to issue LILAK stock at $40 when it was trading 9x…

• Bear Case – If Chile and PR show flat growth while CWC EBITDA contracts to $800MM annually, LILAK would earn ~$1.25 in FCF/sh. 12x FCF and 7x EBITDA would yield ~$15/share.

• Bull Case – If CWC synergies exceed targets and operations improve, combined with accretive M&A, LILAK could easily see $3/sh in FCF in 2018/2019 and warrant a premium multiple for growth. 20x yields $60.

• RBC had a bull case price target of $75 for LILAK twelve months ago

Risks

• LILAK is exposed to Latam/Caribbean markets which are poorer and more cyclical than US/European telco peers

• LILAK has experienced execution issues in certain markets (Trinidad, Barbados) which could continue for longer than CNM3D estimates

• Rising rates could pressure “leveraged equity” stories

Expected timing & Catalysts

• Quarterly Reports – Numbers – As LILAK reports quarterly numbers, consensus will realize numbers have bottomed out and stock is too cheap to peers

• Q1 guidance appears beatable

• Quarterly Report – Separate from LBTYA – LILAK previously reported along with LBTYA. As LBTYA is a far larger story, hardly any questions were asked about LILAK. Starting with Q4, Liberty is holding separate calls and presentations for each tracker. The additional disclosure and emphasis will make LILAK easier to understand.

• Hard Spin – H2 2017 or 2018 – LILAK and LBTYA are tracker stocks, but a hard spin is planned for H2 2017 or 2018. This will close whatever “tracker discount” is currently embedded in LILAK stock.

The Setup – CWC Numbers

The big question mark hanging over LILAK stock is “what is going on with CWC?” The segment has seen two guidance reductions – though in my opinion investors mainly just didn’t understand what they owned. While Q4 beat guidance, analysts are still afraid there are “more shoes to drop.” If CWC numbers have indeed bottomed out and will grow in 2017 and 2018, I believe it is very likely the stock will appreciate given the large and obvious discount to peers.

2017 Street estimates are range from $870MM to $970MM compared to a runrate of ~$890MM in 2016, bracketing to slightly below management’s 2017 guidance. Despite a significant pop following Q4 results, LILAK shares have pulled back and are up only modestly YTD, indicating lingering buyside concerns. However, given the ~$900MM Q4 runrate combined with further synergies, the $10MM Hurricane Matthew hit in Q4, and continued organic growth opportunities, I am confident CWC will meet or beat guidance and I believe LILAK shares will rally in response.

How We Got Here

LILAK is a tracking stock originally separated from LBTYA in mid-2015, which held Liberty’s interest in two cable companies in Chile and Puerto Rico. The logic was that Liberty was sub-scale in Latam/Caribbean, and by floating a separate tracker Liberty could use the stock to rollup assets, gain scale, and increase value. For reference, Chile and PR have ~44% EBITDA margin versus LBTYA’s European markets at ~50%. Despite the lack of scale, the two contributed assets are solid cable companies facing limited fiber competition that have grown EBITDA at a 7-9% pace consistently for the last few years, despite a recession in PR.

In late 2015, LILAK announced its first acquisition – CWC for ~10.7x EBITDA. Making things more complex, CWC itself had purchased another Malone company – Columbus International – in early 2015 for just over 12x EBITDA. Columbus was the high quality fiber asset in the Caribbean while legacy CWC was the “low to no growth wireless player.” The logic was that acquiring CWC and Columbus, LILAK would have a large platform to acquire additional Latam/Caribbean assets, and that when CWC+Columbus was incorporated into Liberty Global’s organization, significant synergies would be unlocked.

There are three interesting details to the LILAK+CWC transaction. First, Malone did not want to use LILAK stock at $40 to purchase CWC because he felt it was undervalued. Instead, he issued stock mainly in LBTYA, which was then spun off to LBTYA shareholders in June. Second, Malone has repeatedly increased his exposure to LILAK by merging his CWC stake and accepting no cash, only stock. Third, Malone had an option to put back his CWC stock to the company if he did not like the investment – instead of exercising that CWC put, he chose to accept an even larger equity stake in LILAK. Malone has quite clearly voted with his money that he sees an opportunity at LILAK.

What Went Wrong

LILAK has been crushed from $43 at YE2015 to $23 today for essentially three reasons: 1) additional shares of LILAK were issued to LBTYA shareholders who didn’t want them (June), 2) a month after the share issuance, LILAK immediately rebased CWC estimates lower as Liberty took a dim view on CWC’s accounting, which lowered Street estimates, and 3) LILAK then misexecuted slightly in Q3 and lowered estimates.

Two guidance cuts of SMID cap spinoff from a large cap company = stock down.

Having said that, LILAK’s guidance cut isn’t particularly large, and the majority of selloff is attributable to multiple contraction. In particular, LILAK never guided the Q2 “miss” – sellside was just extrapolating previous CWC estimates – and almost all of the reduction was accounting changes. Further, the Q4 reduction includes a significant impact from Hurricane Matthew. Excluding the Hurriance Matthew impact, CWC missed its H2 guidance by $10-$15MM (~$25MM annualized, ~2% of total EBITDA). The ~$1.7B, or ~30%, reduction in market cap as a result seems overdone.

Finally, the actual “miss” is a combination of a few small factors, not a complete breakdown in trends and CWC exceeded managements guidance in Q4. EBITDA actually grew at CWC in H2.

Segment Analysis – CWC and Columbus

CWC is a particularly complex asset to evaluate. Multiple countries, business lines, JVs, etc. Further, Liberty only reports a very general “CWC” line with earnings, providing a simple topline and EBITDA line summary. To understand the overall picture requires combing through debt and historical equity filings across eight different entities, all of which have been reclassified at various points. Having done that, CWC can essentially be boiled down to six different historical businesses.

Here are the new segments per CWC’s debt filings:

Note: Chile is ~30% of LILAK EBITDA and PR is ~10%. I did not include CWC corporate expense above, which is ~5% of EBITDA.

I will not go too deeply into any business, but excluding Trinidad and Barbados, which I address below, all businesses are performing inline with the past few years. CWC also lost its monopoly in the Bahamas, but that had been known for years and CWC is actually executing well there. The trouble is less “CWC is falling apart” so much as “CWC is complex to understand, so people don’t know what’s happening.”

For perspective, CWC’s growth rates are similar to the growth rates seen at competitors. Digicel, CWC’s chief wireless competitor, has had flat revenue growth the last few years. Residential cable/fiber is a clear secular winner with HSD EBITDA growth in US, Europe, and rest of Latam. Wholesale fiber has seen pricing issues across geographies (Columbus better than most as subsea more scarce), while enterprise telco services are growing significantly across world (cloud, VPN, etc.) Landlines are in decline everywhere.

Basically, CWC is growing exactly as you’d expect given their exposures to different telco verticals.

Segment Analysis – Chile and Puerto Rico

Despite being ~40% of EBITDA, my write up will spend little time on these assets as there is little controversy here.

Chile (VTR) has been an excellent asset with consistent HSD EBITDA growth over the last decade, despite difficult macro environments in 2008/2009 and 2015/2016. It is a residential video/internet company facing competition from DSL and satellite. VTR also sells wireless plans through an MVNO relationship.

Puerto Rico (Liberty PR) is the main cable company on the island. Despite the current headwinds to PR macro, Liberty has shown strong growth.

LILAK only owns 60% of Liberty PR, but LILAK retains the right to buyout the other 40% at Liberty’s discretion. The jump in EBITDA from 2014 to 2015 is mainly the merger with the other large cable company. Organic trends have seen ~5% annual growth.

CWC Q2 Miss

Put simply, this is mainly due to modeling errors, not CWC fundamentals. LILAK provide no quarterly guidance when they purchased CWC, so the sellside/buyside analysts simply took CWC’s Q1, FY2015 numbers and extrapolated into their 2016 numbers. However, CWC had some aggressive accounting gimmicks that boosted Q1/FY2015 EBITDA numbers, and Liberty has taken a more conservative approach.

Off Liberties rebased numbers, CWC’s Q2 EBITDA grew 2% with topline flat.

CWC Q3 Miss

CWC reported Q3 EBITDA of $215MM, up 2% y/y, and guided Q4 to $220MM, missing Street estimates of $230MM in Q3 and $240MM in Q4. CWC also missed by ~$30MM on topline, as revenues fell 4% on topline vs expectations of flat.

At first glance, the CWC miss looks bad in Q3 – two quarters in a row the sellside has reduced estimates. However, once you dig through the messy details, it’s mainly minor issues. The EBITDA miss was mainly Hurricane Matthew and the revenue miss is again analyst’s poor modeling. The only execution-related worry is the misfire in CWC’s residential cable and mobile businesses in Trinidad and Barbados. While concerning, Trinidad and Barbados combined are less than 10% of EBITDA and have only seen an ~5% drop YTD – not good, but not enough to drop LILAK fair value 50%.

Conceptually, the Q3 miss can be broken down into four main buckets:

• Bad execution in Trinidad and Barbados, particularly on video (~$5-10MM in Q3 and Q4 EBITDA)

• The sellside underestimating the impact of Hurricane Matthew and other previously known Bahamas issues (~$10MM Q4 EBITDA, unquantified Q3 impact)

• A large, one-time contract timing/loss in Panama (~$8MM in Q3 revenues)

• Continued accounting changes by LILAK to rebase legacy CWC ($3-4MM revenues)

Of all the parts of the miss, Liberty’s poor Trinidad and Barbados performance is their only operational screw up. Liberty is rebranding all the legacy CWC Wireless plans as “FLOW” while attempting to reduce pre-paid wireless, push post-paid and emphasize the bundle. They lost track of the ball, and stumbled particularly hard in video. Trinidad lost ~2.5% of video subscribers Q/Q, and Barbados has seen two Qs in a row of 10% sales declines. The chief culprits are competition and macro, with a bit of “self-injury.” Digicel is rolling out fiber to certain locations in Trinidad and Barbados in response to the competitive threat the combined CWC+Columbus poses. Trinidad is in a bad recession - ~35-40% of GDP is oil and gas, and the overall economy contracted 3-6% YTD. However, I estimate Trinidad and Barbados combined are only ~10% of LILAK EBITDA. Continued weakness isn’t good, but it’s not going to sink overall LILAK growth.

The Bahamas miss is largely A) Hurricane Matthew and B) the sellside/buyside not really understanding these assets. Hurricane Matthews devastated the Bahamas and LILAK guided to a $10MM hit to Q4 EBITDA (rebuilding, near term lost subs, etc.). However, the impact should be mainly one-time. Excluding Matthew, CWC has known for years that 2016 would be a bad year in the Bahamas, as their monopoly in wireless is ending. CWC is cutting pricing in response and anticipates elevated churn. I expect that to continue for a few more years. Most importantly, the Bahamas have always had weak margins and LILAK only own 49% of the JV, so the Bahamas are only 3-4% of total EBITDA. While the noise can cause a topline miss, it does not significantly impact LILAK FCF.

Excluding the end/loss of one contract in Panama, Managed Services continued grew inline with historic trends, up 5-8% in the Q. Large contracts are now only 21% of total Managed Services sales, down from 29% in Q3 2015. Larger misses happen in chunky segments like this, as do large gains when a new, big contract comes in. It’s just part of the business.

LILAK continues to take a more conservative view on revenue recognition than CWC, which was a small drag to revenues in Q3. Does this mean LILAK overpaid for CWC? Sure, but the stock is down 50%. I am not overpaying for CWC buying it here.

Q4 Results

LILAK results were “much of the same,” but guidance was (finally) accurate, hence the stock surged at first. Chile and PR were again strong, with Chile guided to a particularly bright 2017. Managed services bounced back nicely, up 17%, driven by Panama correcting from a weak Q3 due to contract timing. Bahamas was predictably weak but held in relatively well with improving topline trends, despite Hurricane Matthew and the new competitive pressure.

Trinidad and Barbados continued their weak result, with video subscribers falling yet again. However, the outlook as has brightened here. As previously discussed, Digicel is the main non-macro issue here, and they recently announced a 25% global workforce reduction along with a significant drop in capex. Digicel is caught in the undercapitalized wireless carrier dilemma – invest in fixed convergence or lose market share. For now, Digicel must preserve capital and the lessening competitive intensity should aid LILAK. Further, LILAK is the process of divesting the TSTT in Trinidad, and will likely petition for and be granted a third wireless license there.

Note: The following models historical details are not fully updated for Q4 as the debt filings are not out yet. However, Q4 was largely inline with my expectations. My 2017 estimates are updated. My share buyback assumptions are above management’s guidance – I do not believe LILAK will be sub-3x levered anytime soon. My adjusted FCF calculation is based on ~13.5% capex/sales, adjusted for proportionate ownerships. The 2016 and 2017 FCF/sh projections above are modestly conservative to my model.

Peers

Product Mix

Catalyst

• Quarterly Reports – Numbers – As LILAK reports quarterly numbers, consensus will realize numbers have bottomed out and stock is too cheap to peers

• Q1 guidance appears beatable

• Quarterly Report – Separate from LBTYA – LILAK previously reported along with LBTYA. As LBTYA is a far larger story, hardly any questions were asked about LILAK. Starting with Q4, Liberty is holding separate calls and presentations for each tracker. The additional disclosure and emphasis will make LILAK easier to understand.

• Hard Spin – H2 2017 or 2018 – LILAK and LBTYA are tracker stocks, but a hard spin is planned for H2 2017 or 2018. This will close whatever “tracker discount” is currently embedded in LILAK stock.